deregulating self-regulated shared atm networks

Econ. Innov. New Techn., 1990, Vol. 1, pp. 85-96 Reprints available directly from the publisher by license only

© 1990 Harwood Academic Publishers GmbH Printed in Great Britain Photocopying permitted

DEREGULATING SELF-REGULATED SHARED ATM NETWORKS STEVEN C. SALOP' Georgetown University The development of shared ATM networks raises important issues of competition, cooperation and standardization. Sharing necessarily involves cooperation among competing ATM owners and card issuing financial institutions. Networks adopt rules that regulate members' pricing decisions also involve issues of standardization and competition. In particular, most networks make ATM owners sell at wholesale by mandating of interchange fees to replace retail market competition among ATM owners. Networks argue that these rules are necessary to present consumers with a standardized product instead of the chaos of the marketplace and to maintain the integrity of the complementary products offered by members. These are, of course, similar to the standardization and compatibility issues raised in other networks contexts. The paper analyzes the need for this system of fixed interchange fees and sets out a proposal to replace the current system with free market price competition by ATM owners. KEY WORDS: shared ATM networks, fixed interchange fees, standardization, free market

I. INTRODUCTION Automatic Teller Machines (ATMs) are one of the most dramatic developments in consumer banking in the last two decades. An ATM allows a consumer to access his or her bank account electronically, without the need to deal with a bank teller. Consumers can make withdrawals, balance inquiries, transfers among accounts and, in some systems, make deposits and pay bills. Most ATM systems initially were deployed into single bank networks of ATMs located at banks ("on premise"). Over time, financial institutions have linked up their proprietary systems into regional or even national shared networks. These shared networks allow consumers with a single plastic "debit" card to access their accounts from all the ATMs owned by all network members, not just those operated by their own banks. These shared networks also provide the economies of scale necessary to support the economical deployment of ATMs at convenient non-bank ("off premise") locations such as supermarkets, shopping malls and convenience stores. The development of shared ATM networks raises important issues of competition, cooperation and standardization. Most regional networks are organized as joint ventures owned and controlled by competing financial institutions. Sharing necessarily involves cooperation among competing ATM owners and card issuing financial institutions. Consumer convenience increases and unit costs fall as more competitors join and add ATMs and cards to the network. Maintaining adequate competition while permitting cooperation that enhances efficiency and consumer welfare can be difficult. Policy makers may face fundamental tradeoffs between the benefits of cooperation and the benefits of competition? 'Professor of Economics and Law, Georgetown University Law Center. I would like thank Paul David, Thomas Krattenmaker, Daniel Prywes, Garth Saloner, Robert Skitol, Scott Engle and Warren Schwartz for helpful comments on previous drafts. This paper also reflects joint work with Nicholas Economides. 'See Felgran (1984, 1985) for earlier analysis of some of these issues. 85

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Establishing an ATM network obviously involves standardization in a number of areas. Standard communication protocols must be established, software must be linked, and other technical standards must be chosen. But standardization goes beyond technical communication issues. For example, the network must choose a logo and decide on the relative importance of the network logo versus the logos of individual bank members to present to users. Similarly, the network may create minimum (or maximum) standards for terminal capabilities that could affect quality competition by ATM owners. Networks also adopt rules that regulate members' pricing decisions. These also involve issues of standardization and competition. As discussed below, most networks make ATM owners sell at wholesale by mandating of interchange fees to replace retail market competition among ATM owners. Networks argue that these rules are necessary to present consumers with a standardized product instead of the chaos of the marketplace. They also claim that these pricing standards are needed to maintain the integrity of the complementary products offered by members. This is, of course, similar to the design standardization and compatibility issues raised in other networks of complementary products. The paper is organized as follows. Section II introduces the basic structure of competition and cooperation in a shared ATM network and the pricing issues involved. Section III sets out a proposal to replace the current system of fixed interchange fees with free market price competition by ATM owners. The efficiency justifications for the interchange fee system are analyzed in Section IV. The Conclusion briefly discusses the historical reasons why the current system was adopted.

II. THE STRUCTURE OF SHARED ATM NETWORKS Shared ATM networks are comprised of institutions that issue debit cards and own ATMs. The debit cards of one institution can be used at ATMs deployed by all network members. In its simplest form, all the ATMs in the network are connected to the data centers of the card issuing banks through a master electronic switch owned and operated by the network.' This network configuration is pictured in Figure l: Most of the largest regional ATM networks are self-regulated joint ventures of some or all of the members. Of the 20 largest regional networks, only 6 are proprietary.' This joint venture structure is not surprising. Many of these networks were formed by linking together the proprietary networks of a number of the large financial institutions in a locale. A network has two main functions. The primary function is to route transactions through the master switch and act as a clearinghouse to settle those transactions. This activity involves development of standard protocols and administration of computer hardware and software. The second function involves marketing the network trademark to maintain and increase the network card base and ATM base. Membership and usage can be encouraged by the quality of the switching service, promotional activities and pricing.

'In many large networks, however, the structure is more complex. ATMs and card issuer data centers are connected to "intercept processors" that act as sub-networks for transactions among their clients. The processors, in turn, are interconnected through the network's master switch. 'See "1988 EFT Network Data Book," published in 6 Bank Network News 1 (November 25, 1987).

DEREGULATING SELF-REGULATED SHARED ATM NETWORKS

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Network Switch

ATM B Figure 1.

ces-switch fees, interchange fees, foreign fees and user surcharges. Switch fees are paid sfer paid by the card issuing bank to the ATM owner. The foreign fee is paid by the ATM owned by another bank. The user surcharge is paid by that consumer to the The switch fee is levied on ATM transactions routed through the master switch. A network must levy some sort of switch fee (or membership fee) in order to recover the costs of operating the central switch. Analysis of the efficient switch fee goes beyond the scope of my analysis. Instead, I focus on the other three fees paid to the banks that are members of the network. The interchange fee is a charge on each transaction routed through the master switch. The interchange fee is not paid to the network. Instead, it is a transfer from the bank that issued the debit card used for the transaction to the owner of the ATM used for the transaction. Virtually all shared ATM networks fix the interchange fee collectively, rather than permitting pairs of members to negotiate the interchange fee (or other arrangement) to govern transactions made by their depositors.' This cooperative price setting is the main focus of this paper. To fully analyze the interchange fee, it is also necessary to consider the other two prices - foreign fees and user surcharges. Most banks charge their depositors a "foreign fee" whenever a depositor uses a "foreign" ATM, that is, one owned by another bank. Similarly, the foreign ATM owners could charge those same consumers user surcharges (or give rebates) for using their ATMs. Virtually all shared networks allow member banks complete control over their foreign fees while prohibiting user surcharges and rebates. Indeed, in some networks, the communications software could not easily accommodate surcharges and rebates. Assuming that foreign fees and user surcharges are set independently and perfectly competitively, the interchange fee is redundant. The level of the collectively set interchange fee does not affect the ultimate prices paid by consumers. For example, suppose the interchange fee were 50 cents. Suppose the ATM owner wants to realize 65 cents so it charges a 15 cent surcharge. Similarly, suppose the card issuer requires a foreign fee 30 cents over the interchange fee so it sets a foreign fee of 80 cents. Now, suppose the interchange fee is reduced arbitrarily to 40 cents. Equilibrium can be bli h d if h h i i d 25 d h f i f i 'ATM interchange fees vary in the 25-75 cent range. Fees sometimes vary by the type of transaction (e.g cash withdrawal vs. balance inquiry) or location of the ATM (on or off premise).

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reduced to 70 cents. Either way, the ATM owner realizes revenue of 65 cents and the consumer pays a total of 95 cents. These calculations show that the interchange fee may be eliminated if surcharges and foreign fees are permitted. Suppose the interchange fee were set equal to zero. Equilibrium could be reestablished with a user surcharge equal to 65 cents and a foreign fee equal to 30 cents. Where user surcharges or foreign fees are constrained or prohibited, the level of the interchange fee creates conflicts of interest among network members because the interchange fee is a transfer from one member to another.' In the short run, a low interchange fee will benefit institutions that specialize in issuing cards because these banks are net payers of interchange fees. In contrast, a low interchange fee will harm institutions that specialize in providing ATMs because these banks are net receivers of interchange fees. Of course, for banks that are perfectly balanced between card issuing and ATM ownership, the level of the interchange fee is irrelevant to its cash flow. If the bank's depositors use "foreign" ATMs as often as "foreign" depositors use the bank's ATMs, its interchange fee costs will just equal its interchange fee revenue. The longer run effects of the interchange fee, foreign fee and user surcharge levels are more complicated, due to the interrelationship between prices, ATM deployment and ATM usage. As a result, even members who are in balance would care about the level of these fees. In this regard, total ATM usage depends on two main factors - the number (and convenience) of ATMs on the network and the total price users must pay per transaction. That total price is the sum of two components, the user surcharge plus the foreign fee. The level of the foreign fee would depend on the interchange fee. In the simplest case, where the foreign fee equals the interchange fee plus a constant (suppressed in the equation, for simplicity), we have Q=D(n,p+s) where n denotes the number of ATMs in the network, p denotes the interchange fee and s denotes the user surcharge. We denote the two demand effects as the "convenience elasticity" and the "price elasticity." The long run analysis is complicated because the supply of ATMs depends positively on the per transaction total revenue p + s received by the ATM owner, or n = S(p + s) (2) If the number of ATMs is low or if they are inconveniently located, consumers will have little incentive to utilize the network. At the same time, if usage is low, then the incentive to deploy ATMs is reduced. Thus, a combination of interchange fee and surcharge that is "too low" actually could discourage usage by discouraging ATM deployment despite the beneficial effects of low fees on usage. Substituting equation (2) into (1), differentiating with respect to the total fee f = p + s and rewriting in terms of elasticities, usage rises with increases in the total fee if and only if the product of the convenience elasticity (E„) times the supply elasticity (ES) exceeds the price elasticity (EP), or E„ E, > EP 'For an earlier discussion of these conflicts of interest, see Phillips (1987).


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where the price elasticity is defined as a positive number. Industry participants and surveys suggest that demand is highly price inelastic. The number of transactions per ATM has remained relatively constant across networks and over time, suggesting that the convenience elasticity is about one, or slightly less. The supply price elasticity exceeds unity if ATM technology has a fixed cost and constant marginal costs.' These figures would imply that raising total fees paid to ATM owners marginally above current levels would increase total usage by increasing ATM deployment and convenience. III. THE FREE MARKET PRICING PROPOSAL Economic theory teaches generally that prices independently determined in a free market are more likely than jointly-fixed prices to achieve a mix of price, quality and convenience desired by consumers with diverse preferences and incomes. However, price competition is not the norm in ATM networks. Most networks prohibit user surcharges and set the interchange fee collectively. Thus, the full price received by the ATM owner is set by the Board of the network. It is required to sell ATM usage on a wholesale basis to the card issuing banks who then package it with other components of the depository relationship for resale to consumers. As discussed below, this joint fee setting is both unnecessary and unlikely to benefit consumers. A. Benefits of Free Market Competition

This joint pricing mechanism denies consumers the benefits of free competition among ATM owners. All consumers are required to take the same mix of price, convenience and service. All ATMs receive the same price, regardless of cost and convenience. This is unlikely to be optimal. The current system has not provided consumers with a mix of ATMs they prefer. For example, most ATMs are located at banks ("on premises"). Yet, consumers would prefer relatively more ATMs located at non-bank ("off premise") locations. These off premise ATMs probably increase total network transactions rather than simply increasing convenience for the same number of transactions. However, off premise locations are more expensive to serve because of the higher costs of replenishing the cash supply and rent on the space. Unless ATM owners can recover these higher costs, insufficient off premise ATMs will be provided. Off premise ATM deployment can be encouraged, of course, by setting a higher interchange fee for those ATMs. The Pulse network provided for an off premise premium. However, setting the efficient fee differential is quite difficult and would represent a self-regulatory nightmare. First, the differential should account for demand as well as cost elements. Second, it is doubtful that the same interchange fee should be set for all off premise ATMs. ATM's also differ according to the potential volume of the location and the value consumers would place on the addition of an 'That is, break-even output per ATM q would be given by f = c + K/q, where c equals marginal cost and K equals fixed costs per ATM, Assuming that all ATMs are identical so that every ATM gets a 1/n share of total usage Q, then q = Q/n. Substituting, we have _ (f - c)Q/K and the supply price elasticity (holding Q constant) exceeds unity.

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ATM at that location. Therefore, it would not be surprising that collectively set prices would fail to maximize consumer welfare. Collective price setting also fails to provide ATM owners with the continuous feedback about consumer preferences and costs that is the strength of the free market. Collective price setting tends to be static and rigid. Interchange fees seldom change. This has certainly been the case for many ATM networks. One reason for this rigidity is coordination costs. As Phillips (1987) emphasizes, it is difficult for a large number of institutions to reach agreement on an issue like interchange fees, where there are substantial conflicts of interest among members. B. Replacing Interchange Fees with Competitive Prices Given these criticisms of joint price setting, an alternative would be to adopt a free market approach to ATM pricing. This would entail replacing the interchange fee with user surcharges and foreign fees independently and unilaterally determined by individual ATM owners. For example, if an ATM owner set a 65 cent user surcharge and the consumer withdrew $40, the consumer's account would be debited a total of $40.65. In this way, consumer preferences and costs could determine ATM deployment and prices, not the collective desires of those banking competitors that control the network. IV. EFFICIENCY JUSTIFICATIONS FOR COLLECTIVE INTERCHANGE FEES There are a number of possible justifications for collective determination of interchange fees and prohibitions on user surcharges and rebates. These involve maintenance of consumers' universal access to all the ATMs in the network, elimination of price dispersion, elimination of price gouging, protection of complementarity and avoidance of conversion costs. A. Maintaining Universal Access to Network ATMs ATM networks have asserted that joint determination of interchange fees is necessary for the viability and efficient operation of the network. Applying analysis developed originally by Baxter (1983), ATM networks argue that the transactions costs of bilateral interchange fee negotiations between network members would be prohibitive, given the large memberships of the networks. Moreover, and more importantly, if a substantial number of bank pairs did not reach agreement, then the ATM card would not enjoy universal access to all the ATMs in the network. Instead, each consumer would need to learn which ATMs could be used with his or her card. By eliminating these benefits of ubiquity, the value of the network trademark would be weakened. The logo would no longer signify the certainty that the card would work on every ATM in the network. In the NaBanco antitrust case, the court accepted this justification for collective interchange fee determination by the Visa credit card network.' However, this justification is flawed in the context of ATM networks. It assumes the necessity of some interchange fee paid by the card issuing institution to the ATM owner. However, as 'National Bankcard Corp. (Nabanco) v. VISA U.S.A., Inc., 779 F.2d 592 (11th Cir. 1986). In credit cards, consumer surcharges are permitted by the Fair Credit and Billing Act.


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discussed earlier, interchange fees are not necessary at all. Instead of interchange fees, the network could permit each ATM owner unilaterally and independently to set user surcharges for its ATMs. Independently determined foreign fees would continue to be permitted. In this way, free market price competition among ATM owners would replace collective price fixing.9 This free market approach to ATM pricing would not increase negotiation costs because no interbank pricing negotiations would be necessary. The user surcharge would be clearly disclosed on the ATM machine and each consumer would decide individually whether or not to pay the posted price at a particular ATM. At the same time, the benefits of universal access and ubiquity would be preserved: every card would work in every ATM on the network. No ATM network currently takes a free market approach to ATM pricing, although a number now permit user surcharges. However, paper check cashing is organized in this way. A check cashing outlet such as a supermarket charges whatever price it chooses (including zero) for cashing a check. The check then is routed back to the depositor's bank, where it is honored if there are sufficient funds, regardless of the check cashing fee imposed. B. Eliminating Price Dispersion ATMs are differentiated by location and exhibit scale economies. As a result, if price competition among ATM owners were permitted, price dispersion likely would result. Some ATM owners would deploy ATMs in locations that are highly convenient for a few consumers; these low volume ATMs would require higher user surcharges to cover costs. Other ATMs that achieve high volumes could profitably be priced low. Excess capacity of on premise ATMs at banks clustered together in downtown areas also might lead to very low equilibrium prices. This price dispersion might have two adverse effects. First, consumers could be confused by the price dispersion and stop using ATMs altogether. Second, the existence of price dispersion creates the need to shop, increasing search costs. By eliminating price competition, simplicity is obtained. the Pulse network denoted this "new product" created by the elimination of price competition as "no hassle cash." These fears of the chaos and hassle of competition are commonly expressed by firms facing deregulation. But they are not a good reason to block the free market. Indeed, one of the primary benefits of free market competition is to offer ATM users a variety of price, quality and convenience options. There is no reason to think that ATM price dispersion would be extraordinary, relative to other goods and services consumers successfully purchase every day. ATM services are an inexpensive, repeatedly purchased, convenience good just like bread, soft drinks and gasoline. Reputation formation should be rapid. Consumers tend to patronize the same few ATMs repeatedly in the course of their daily routine and would quickly learn which are bargains, relative to the convenience and quality provided. Nor should consumer confusion create serious problems as long as ATM user fees are disclosed on the terminal. Consumers already engage in search to economize on ATM foreign fee charges. Consumers competently contend with similar price disperTThis free market approach could not apply to determination of the switch fee or membership fee, of course. Those fees are necessary for the viability of the network and can only be set collectively.

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should be more anxiety provoking." Finally, this defense is boundless. Every potential cartel could claim this alleged benefit. C. Eliminating Price Gouging A related criticism of free market competition involves the fear of monopoly pricing or "price gouging." However, significant consumer harm from monopoly pricing is unlikely. Numerous firms currently own and operate ATMs and entry into ATM deployment is cheap and easy. Moreover, where ATMs are located in supermarkets or other retail locations, the retailer has an incentive to maintain low ATM prices to attract customers. Prices may be higher in low volume locations that could not support an ATM at lower prices. But, this is a benefit of price competition, not a flaw. It may well be that too many ATMs currently are deployed in some areas (e.g. where bank branches are concentrated) and too few are deployed elsewhere (e.g. in the non-bank locations consumers find more convenient). However, this problem currently arises from the lack of pricing independence by ATM owners, not the opposite. If there were price competition among ATM owners, prices would be driven down in the excess supply areas and up in excess demand areas, creating an incentive to redeploy ATMs to the more preferred areas. It could be argued that ATM price competition might lead to the incorrect degree of locational differentiation. However, similar to the point just made, locational differentiation also exists with fixed interchange fees; but unlike the free market, there is no pricing mechanism to provide any balance of cost and convenience based on diverse consumer preferences. In addition, this justification is somewhat disingenuous. ATM networks do not carry out the type of studies that would be necessary to optimize product variety." Finally, monopolistic competition is ubiquitous. Therefore, this non-optimal variety argument could be used to justify industrywide price fixing in cereals, airlines and gasoline retailing, for example. It also would be difficult for a court or regulatory agency to distinguish between well-meaning defendants who want to increase consumer welfare from those that intend to cartelize under the veil of efficient regulation of product variety.

D. Protecting Complementarity A more sophisticated version of the "price gouging" criticism involves the complementarity between card issuing and ATM deployment. Potential network externalities obviously do arise in ATM networks. ATM owners benefit from increasing the number of cardholders and vice versa. Similarly, if ATM owners raise fees and thereby decrease overall usage, switch volume will fall, thereby harming card issuers who lose foreign fee revenue. However, Cmplementarity cannot justify networks' desire to eliminate price competition by ATM owners for three reasons. First, networks do not regulate the foreign fees charged by card issuers. Yet, the "It is possible that there could be some minor transitory confusion when the free market is first implemented. To minimize this, it would make sense for the network to carry out consumer education and possibly require additional information disclosure by members. For a survey of these techniques, see Beales, Craswell and Salop (1981). "For example, see Spence (1976) and the papers cited in Salop (1979).


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two fees have identical roles in the complementarity relationship. The consumer's total cost for a foreign ATM transaction is the sum of the user fee plus the foreign fee. A high foreign fee by one institution reduces ATM usage and thereby injures ATM owners. It also harms other card issuers and their depositors by lessening convenience, if the decreased usage reduces ATM deployment. Therefore, for a network to justify prohibitions on user surcharges as a means of protecting against adverse network externalities while allowing foreign fees to be determined by depository account competition is illogical." Second, complementarity with this type of network externality is common in the economy. Permitting competitors to fix prices whenever any network externality can be identified would be difficult to contain. Paper checks are an obvious example. Whenever a supermarket chain reduces its check cashing fees or begins to cash payroll checks, benefits accrue to the local banks and consumers with checking accounts. Similarly, although airline scheduling at an airport exhibits similar complementarities and network externalities, allowing all the airlines serving O'Hare airport to set air fares jointly would raise serious competitive concerns. Nor would anyone seriously suggest that all manufacturers of IBM-compatible hardware and software be permitted to price jointly. Third, there are far less restrictive alternatives available to protect or optimize the complementarity relationship. The potential problem raised by complementarity is that the free market may fail to provide the optimal number and mix of ATMs and bankcards. If a network concluded on the basis of a rigorous cost-benefit analysis that ATM deployment was suboptimal, it could directly subsidize (or tax) additional ATM deployment, as a supplement to free market price competition.". Although this procedure may be difficult, it would ensure that joint fee setting maximizes consumer welfare and does not turn into cartelization by the dominant side of the network membership. Perhaps more to the point, it is precisely this type of analysis that a self-regulated network would need to carry out in order to set optimal interchange fees. The very difficulty of this type of study indicates why free market pricing is superior to collectively set prices. In short, the existence of economic interdependencies and benefits of cooperation does not imply that unrestrained, anticompetitive joint price fixing must be tolerated. Although the free market may not perfectly internalize all the externalities, it is likely to be more efficient than collective price fixing by a self-regulated network.

E. Economizing on Conversion Costs

Certain costs would be entailed by a move to free market pricing. These costs involve consumer education, planning and modification of network and member software. While certain conversion costs must borne, policymakers should be wary of permitting such transition costs to justify permanent restraints on competition. Obviously, if it is absolutely infeasible to reestablish competition, then competition cannot be adopted and interchange fees must remain the transaction revenue base for ATM owners. However, transition costs usually are far more modest. Moreover, "If anything, it probably would make more sense to constrain foreign fees and rely instead on user surcharge competition than the reverse. It is easier to switch ATMs than to change banks. I currently am exploring this issue in joint work with Nicholas Economides. "One might use the effects on usage, as given by equation (3), as a first approximation for efficiency.

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efficient self-regulation is an expensive process itself. Allowing modest conversion costs alone to justify continued impediments to competition creates peculiar incentives for future joint ventures. If a venture that raises the cost of restoring competition is permitted to prevail, then future ventures would attempt to organize in ways that minimize flexibility. In this way, once they become established with a less competitive structure, they can maintain that structure into the future. Instead, legal incentives should be created for ventures initially to organize themselves to maintain competition, not cartelization. This is, of course, the policy that should be encouraged in other standardization contexts as well. V. CONCLUSIONS This paper has argued that collectively setting an interchange fee and prohibiting price competition by ATM owners likely is inefficient. Such self-regulation is unlikely to provide higher consumer welfare than vigorous free market competition among the ATM owners in the network. Networks concerned with efficiency and competition ought to deregulate their pricing rules to allow price competition among ATM owners. This conclusion raises two further questions, however. First, if the free market is superior to collectively set interchange fees, why did these networks historically adopt interchange fees instead of the free market? Second, why has this inferior institution survived in the face of inter-network competition? As mentioned earlier, many ATM networks initially were formed by linking up the proprietary networks of individual banks. Those institutions viewed ATMs as an adjunct to the traditional bank-depositor relationship, not as a separate profit center. By creating a network, depositors were given access to a larger ATM base without the bank needing to invest in additional ATMs. The networks involved a quid-pro-quo among banks: "I will allow your depositors to use my ATMs if you allow my depositors to use your ATMs." This view had a number of implications for network pricing regulations. First, it probably seemed natural for the founders to agree to create a wholesale market (among banks) by using interchange fees rather than creating a retail market (between the "foreign" ATM owner and one's depositors) by permitting instead user surcharges. They were concerned with ATMs as an adjunct of the depository relationship, not in creating a competitive open network that would provide a depositor with an alternative means of accessing his account. By creating the wholesale market, each bank maintained full control over its depositors." Second, the banks apparently assumed that each would be roughly balanced between paying and receiving interchange fees, so that net interchange payments would equal zero. In this situation, the level of the interchange fee has no effect on cash flow in the short run. Moreover, foreign fees were nonexistent when the networks formed Thus the only role of the interchange fee was to affect "This control was particularly important at the time many networks were formed because price (i.e. interest rate) competition among banks was constrained by regulation. ATMs were a way to partially escape the regulation and offer a better price-product package to consumers. Of course, this regulatory motive no longer applies.


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founders, who already were increasing the size of the ATM base by forming the network. Although this structure did not maximize interbank ATM competition, maximizing competition was not the goal of the founders. Moreover, they may not have anticipated that over time, the membership would become unbalanced between card issuing and ATM ownership and conflicts among members would ensue." Indeed, the issue of interchange fees became controversial when certain banks began to expand their ATM deployment to earn revenue by providing network access to depositors of other banks. In this regard, there have been two major antitrust challenges to the interchange fee-no surcharge system. Both involved objections made by banks that focus on ATM deployment. Their challenges were fought by the large card issuing banks that were net payers of interchange fees. In the Pulse arbitration, First Texas Savings had deployed ATMs in convenience stores throughout Texas. When the Pulse network proposed to reduce the interchange fee, First Texas objected to the interchange fee system generally. The arbitrator concluded that Pulse could only set interchange fees if it also permitted ATM owners to add user surcharges or rebates." In another dispute, Valley Bank of Nevada deployed ATMs in various Las Vegas casinos to allow tourists to withdraw funds. Valley added a one-dollar user surcharge to cover their costs. The Star, INN and American Express networks did not object, but the Plus network did. Valley currently is sucharging transactions while that antitrust case is in litigation. As far as inter-network competition is concerned, one might in principle rely solely on inter-network competition to maintain incentives for networks to choose the most efficient pricing structure. However, the short answer to this policy prescription is that inter-network potential competition is likely to be weak in many cases because of economies of scale and sunk costs, leading to incumbency advantages and critical mass barriers to entry. In short, networks are unlikely to be nearly "perfectly contestable" markets. In this regard, networks are consolidating over time to from local to regional and even inter-regional scope, raising the degree of critical mass problems. In addition, it is not clear that inter-network competition can prevent this type of problem. Thus, relying solely on actual and potential inter-network competition to drive out an interchange fee system is unlikely to be the optimal policy.

References Baxter, W.F. (1983), "Bank Interchange of Transactional Paper: Legal and Economic Perspectives," Journal of Law and Economics, 541-88. r+ Beales, H., R. Craswell, and S. Salop (1981), "The Efficient Regulation of Consumer Information," Journal of Law and Economics, 24, 491-540. Felgran, S.D. (1984), "Shared ATM Networks: Market Structure and Public Policy," New England Economic Review (January/February), 23-38. Felgran, S.D. (1985), "From ATM to POS Networks: Branching, Access and Pricing," New England Economic Review (May/June), 44-60. Kauper, T. (1988), "Opinion of the Arbitrator", in the Matter of the Arbitration Between First Texas Savings Association and Financial Interchange, Inc., August 19, 1988 (reprinted in BNA, Antitrust 's They also may have believed that basing interchange fees on costs would be a simpler exercise than it was. "The author was a consultant to First Texas Savings and to Valley Bank in these cases. For a description of the Pulse case, see Kauper (1988).

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hillips, A. (1987), "The Role of Standardization in Shared Bank Card Systems," in H.L. Gabel, Product Standardization and Competitive Strategy New York; North Holland, 263-73. Salop, S.C. (1979), "Monopolistic Competition with Outside Goods," Bell Journal of Economics, 10, 14156. Spence, A.M. (1976), "Product Selection, Fixed Costs and Monopolistic Competition," Review of Economic Studies, 43, 217-36.